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Best Buy’s Best Option Seen in Founder’s 40% Premium: Real M&A

Founder and largest shareholder might have best offer on table.

Aug. 7 (Bloomberg) -- Best Buy Co. founder Richard Schulze may be offering the best option for shareholders, even as traders question his ability to finance the fourth-largest U.S. retail takeover in history.

Schulze, who remains the electronics chain’s largest investor after stepping down as chairman in June, sent a letter to the board yesterday with an acquisition proposal of $24 to $26 a share, valuing Best Buy at as much as $9.5 billion including net debt. Even at an earnings multiple that’s the cheapest on record in the U.S. industry, the bid is as much as 40 percent higher than the stock’s 20-day price, topping the group average, according to data compiled by Bloomberg.

While Best Buy is trading 17 percent below the low end of the offer because Schulze didn’t name private-equity partners and doesn’t yet have committed financing, the 71-year-old says Minnesota law requires he get the board’s permission to form a bidding group with buyout firms and executives. If Credit Suisse Group AG’s confidence in raising debt leads to full financing, the deal could provide a 14 percent bigger gain for shareholders than analysts project Best Buy will generate on its own in the next year as it struggles to compete with online retailers.

“It’s obviously a pretty good premium,” Joe Feldman, a New York-based analyst at Telsey Advisory Group, said in a telephone interview. “A lot of investors may say this isn’t such a bad deal given where things are at right now and the stock otherwise might not get there on its own, so we’ll take it. The issue is just whether they can get a deal done.”

‘Due Course’

Best Buy confirmed in a statement that it had received the letter from Schulze and said the board would consider it “in due course.” A spokesman for Richfield, Minnesota-based Best Buy wouldn’t comment further.

A spokesman for Schulze declined to comment beyond the letter and statement.

Best Buy, founded by Schulze in 1966, sells everything from computers and televisions to DVDs and mobile phones. Schulze said he would explore all available options for his 20.1 percent stake when he resigned as chairman in June after failing to inform the board of allegations that Brian Dunn, the company’s former chief executive officer, had an inappropriate relationship with an employee.

Schulze sent a letter yesterday to Best Buy’s directors offering to acquire the rest of the company’s equity and net debt, valuing the purchase at as much as $7.6 billion, data compiled by Bloomberg show. That would be the biggest takeover of a U.S. retailer since 2005 when Federated Department Stores Inc., now Macy’s Inc., bought May Department Stores Co., and it would also be the industry’s largest leveraged buyout on record, the data show.

Board Negotiations

Schulze has negotiated unsuccessfully with the board for the past several weeks, seeking permission to conduct due diligence and form a bidding group, said a person familiar with the matter. Best Buy’s board told Schulze it wasn’t a good time to go private because it was looking for a new CEO, and asked for three more weeks to consider the matter, said this person.

Best Buy shares yesterday traded only as high as $21.60, less than the low end of Schulze’s proposed offer, before closing at $19.99. While the stock was 13 percent higher than its closing price Aug. 3, the shares were still 17 percent below Schulze’s minimum offer because investors are skeptical he will be able to secure enough money to fund the transaction, said Michael Pachter, an analyst for Wedbush Inc. in Los Angeles.

“I think it’s worth less than where it’s trading at now, so if investors can get more than that, then it’s a great deal,” Pachter said in a phone interview. “The question is, how much will financial institutions be comfortable lending? Can he pull it off?”

‘Highly Confident’

Today, shares of Best Buy fell 2.6 percent to $19.47 at 9:46 a.m. in New York.

Schulze’s letter to the board said he will pay with $1 billion of his own equity, investments from private-equity firms and debt. The letter also said he retained Zurich-based Credit Suisse as his financial adviser and that Switzerland’s second- biggest bank is “highly confident that it can arrange the necessary debt financing.” Standard & Poor’s and Fitch Ratings both cut Best Buy’s credit ratings to junk yesterday.

Schulze is still seeking the board’s permission to conduct due diligence on the electronics retailer and form a group including private-equity funds and other executives to formalize the offer. Under Minnesota corporate law, Schulze needs permission from directors to form the group.

“While I have not yet reached any such agreements, I am confident, based on my discussions to date, that I could in short order if the board allows me to do so,” Schulze said in the letter.

Financing Obstacles

No private-equity firms are named in the letter. Still, Schulze has sought and received interest from funds that want to be part of his effort, and he likely would have two buyout firms backing his offer, said a person familiar with the matter.

“There are a number of obstacles,” said R.J. Hottovy, a Chicago-based analyst for Morningstar Inc. “I’m not convinced he’s going to get approval from all of the board members. The board and shareholders need more information before they will sign off on this deal.”

Once a $29 billion company, Best Buy has wiped out more than three-quarters of its market value as it lost sales to Internet-based retailers such as Amazon.com Inc. and discount stores like Wal-Mart Stores Inc. Best Buy’s same-store sales fell in seven of the last eight quarters, data compiled by Bloomberg show.

‘Runaway Train’

After Best Buy shares declined 32 percent in 2011, the fourth-worst performance among retail stocks in the S&P 500 Index, the stock extended its drop this year by another 25 percent through Aug. 3. The company reported its first annual net loss in two decades in March, and the CEO resigned the next month as the board investigated an inappropriate relationship with a 29-year-old female employee.

Even the bottom of Schulze’s range is more than the $22.89 that analysts expected Best Buy’s stock to reach within 12 months as a standalone company, according to estimates compiled by Bloomberg as of July 29.

“If consumer sentiment is weak and unless there’s some hot new product that nobody knows about, the stock isn’t getting there in the next year,” Louis Meyer, a New York-based special situations analyst at Oscar Gruss & Son Inc., said in a phone interview. “Schulze is saying, ‘Before this thing becomes a runaway train, we need to interject ourselves.’ He sees the urgency.”

‘Penalty Box’

The takeover proposal values the entire company, including net debt, at about 2.9 times its $3.26 billion in earnings before interest, taxes, depreciation and amortization in the last 12 months, data compiled by Bloomberg show. That means Schulze would be getting Best Buy for the cheapest Ebitda multiple on record for a U.S. retail takeover of more than $500 million, the data show.

“When you are in a penalty-box situation, it’s very hard to say what’s a reasonable price,” David Schick, a Baltimore- based analyst for Stifel Financial Corp., said in a phone interview. “It’s obviously a bargain if management thinks it can grow that Ebitda number. It’s not if the pressures are too great.”

Schulze’s bid ranges between a 29 percent and 40 percent premium versus Best Buy’s 20-day stock average before the announcement. Takeovers of American retailers have historically been valued at an average premium of 31 percent, data compiled by Bloomberg show.

“He’s pretty much right on target” in terms of price, said Meyer of Oscar Gruss. The board knows that “nobody’s going to come up with $30, especially if the company is not run any better. There is no $30 bid coming. Another year of pretending nothing bad is happening isn’t going to work.”

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